Sam clarifies in the article: It's time for the Fed to cut interest rates!

The U.S. employment data in July touched the "Sahm Rule," causing concerns on Wall Street. Claudia Sahm, the chief economist of New Century Advisors and the proposer of the Sahm Rule, personally expressed her views as follows.

Despite the indicator named after me showing that the U.S. is in a recession, the reality is that the U.S. has not entered a recession. The Sahm Rule was triggered by last Friday's lower-than-expected employment report, adding to a list of economic tools that have been unusually disrupted over the past four and a half years.

That being said - with humility and concern - the Sahm Rule still applies. The risk of an economic recession has increased, which strengthens the case for the Federal Reserve to cut interest rates.

The National Bureau of Economic Research (NBER) defines a recession as "a significant decline in economic activity that spreads across the economy and lasts for several months or more." NBER typically makes an official determination after evaluating a series of economic data several months later. Currently, most of the data considered by NBER still looks robust. For example, real consumer spending in the second quarter grew at an annual rate of 2.6%, with an average monthly increase of 170,000 jobs over the past three months. A notable exception is the employment situation in household surveys, which has remained flat this year.

Despite the slowdown in economic growth, it is still expanding. At least for now, there is no recession.

However, the situation could change rapidly, and by the time NBER officially confirms a recession, it is usually too late to guide policymakers. The purpose of the Sahm Rule is to serve as an early diagnostic tool. I created this rule in early 2019 with the aim of shortening the wait for NBER's determination and as part of an automatic fiscal policy trigger during economic downturns.

Later named after me, the rule is simple and highly accurate in design: when the three-month moving average of the U.S. unemployment rate is 0.50 percentage points or more above its lowest value in the previous 12 months, the U.S. is already in a recession. Since 1970, the rule has correctly identified every recession and has not triggered outside of a recession (although it came very close in 1976). In 1959 and 1969, the Sahm Rule was triggered outside of a recession but was followed by a recession within the next six months.

However, as any investment prospectus will tell you: past performance is not indicative of future results.

The Sahm Rule relies on a powerful feedback loop: a relatively small increase in the unemployment rate can turn into a substantial rise. Workers losing income can put pressure on consumer demand, leading to more job losses. Rising unemployment is often accompanied by reduced wage growth, fewer job opportunities, and increased overall uncertainty.

During U.S. economic recessions from 1947 to 2007-09, the unemployment rate initially rose gradually and then increased significantly. On average, the peak unemployment rate was nearly 3 percentage points higher than the pre-recession level. The increase in the unemployment rate over the past year aligns with previous recession ranges The level of unemployment is not decisive — change is the most important. For example, at the start of the 1969-70 recession, the unemployment rate was around 3.5%, while at the start of the 1981-82 recession, the unemployment rate exceeded 7%. Over a longer period, changes in the population structure will affect the overall unemployment rate. The Congressional Budget Office estimates that the equilibrium unemployment rate reached over 6% in the late 1970s, slowly dropping to 4% last year, partly due to an aging workforce with more experience. Focusing on short-term changes, such as changes within a year, makes recessions more comparable.

This brings us back to last Friday's employment report. In July, the unemployment rate rose to 4.3%, bringing the Sam Rule to 0.53% — slightly above the trigger threshold. Nevertheless, we have ample reason to believe that the current rise in the unemployment rate exaggerates the recession dynamics.

Last fall, when the unemployment rate began to rise, and this spring, when the unemployment rate significantly increased in several states, I explained why this time might be different — that is, why triggering the Sam Rule may not be an indicator of the U.S. entering a recession. The increase in the workforce, especially the surge in immigration, has contributed significantly to the rise in the unemployment rate.

In an economic recession, the momentum of rising unemployment due to weakened labor demand will strengthen, which is why the Sam Rule has been effective historically. However, the rise in unemployment caused by an increase in labor supply is different. Once job openings "catch up" with new job seekers, more workers can drive economic growth, leading to a decrease in the unemployment rate. The Sam Rule cannot distinguish between these two dynamics, so it appears more severe when the workforce increases rapidly.

There are signs that a stronger labor supply, not just weaker labor demand, has helped push the Sam Rule above the 0.50% threshold. New or returning entrants to the labor market account for about half of the increase in the number of unemployed. This proportion is significantly higher than in recent recessions, where most of the increase came from temporarily or permanently laid-off workers. The current Sam Rule reading may exaggerate the extent of demand weakening and may not have reached recession levels.

Nevertheless, risks still exist. Recessions have occurred during periods of labor expansion, as in the 1970s, so the current situation is not unprecedented in the early stages of a recession. The employment rate has now fallen to the level of 2014, when the unemployment rate was 6%.

Federal Reserve Chairman Powell stated last week that the data shows "the labor market conditions continue to gradually normalize." However, the rise in the unemployment rate over the past year, as reflected by my rule, now appears to have exceeded normal levels and is approaching a worrying level of recession. It is time for the Federal Reserve to use its tools and lower interest rates